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Castrol is sanguine on earnings visibility with 1) resilient demand being
driven by personal mobility and industrial segments and 2) a potential
correction in prices for key raw material - base oil
Key takeaways from the meeting
Base oil prices - a key driver: Base oil prices have had a downtick in
the last month, with decline in crude prices. While Castrol management
does not see base oil prices collapsing from current levels
(US$1,500/MT), they do believe a 13-15% fall in prices is warranted on
account of crude/base oil margins correcting on weaker global demand.
Castrol’s earnings have a 7% sensitivity to a 5% change in base oil
price, according to the company.
Volumes steady, pricing power intact. Castrol expects volumes to be
led by the personal mobility segment (cars, motorcycles) and the
industrial segment (dumpers, earthmovers). Diesel Engine Oil sales are
expected to remain flat. Castrol has taken product price hikes in Dec-10
and Mar-11, aggregating 15%, based on a prognosticated base oil range
of US$1400-1450 –further hikes may not be needed in Castrol’s view.
Castrol trades at 22x CY11P/E (based on Bloomberg consensus data), inline
with Indian FMCG companies. The company attributes this to its
strong brand/pricing power and high capital efficiency ratios.
The stock has outperformed benchmark indices over the last 12 months.
Management attributes earnings resilience to the company's ability to
pass through raw material cost pressures.
NOTE: THIS DOCUMENT IS INTENDED AS INFORMATION ONLY AND NOT AS
A RECOMMENDATION FOR ANY STOCK. IT CONTAINS FACTUAL
INFORMATION, OBTAINED BY THE ANALYST DURING MEETINGS WITH
MANAGEMENT. J.P. MORGAN DOES NOT COVER THIS COMPANY AND HAS
NO RATING ON THE STOCK.
Key takeaways from the meeting
Base oil price trends are supportive
Base oil prices have had a downtick in the last month, with decline in crude prices.
While Castrol management does not see base oil prices collapsing from current levels
(US$1,500/MT), they do believe a 13-15% fall in prices is warranted on account of
crude/base oil margins correcting on weaker global demand. Castrol’s earnings have
a 7% sensitivity to a 5% change in base oil price, according to the company.
Base oil refining margins have sustained at US$400-450/MT over the last 18 months
(v/s average US$200-250/MT earlier). Castrol sees a mismatch in the demand supply
dynamics of semi-synthetic - Group II and Group III base oils v/s the traditional
Group I base oil, while demand is shifting towards the higher grades, capacities are
yet to catch up. However, current high base oil prices have an element of supply
constraints with planned and unplanned shut-down in domestic base oil refineries
and the fire in the Formosa plant regionally disrupting supplies – easing of these
constraints will help temper base oil prices
Volumes outlook is stable; pricing power continues to be
strong
Castrol expects volumes to be led by the personal mobility segment (cars,
motorcycles) - they expect 8-9% volume growth for lubes based on a 15% growth in
vehicle sale volumes in the medium term. Industrial segment volumes (driven by
dumpers/earth moving equipment) is expected to growth at 4-5% , while Diesel
Engine Oil sales are expected to remain flat with technology changes (higher drain
intervals) offsetting vehicle parc growth.
Castrol has taken product price hikes in December-10 and March -11, aggregating
15%, based on a prognosticated base oil range of US$1400-1450. While competition
did not raise prices in 1HCY11, IOC took a big 28% hike in August; market share
impact of this is likely to be felt only in the next few quarter as Castrol management
believes there is a high level of low-price inventory in the distribution channel for
now.
Castrol continues to invest intensively in its brand and expects to maintain
advertising and sales promotion spend at 5-6% of revenues. However, there is a shift
towards more ‘below-the-line’ activities involving decision influencers (mechanics)
– to strengthen brand franchise in that segment.
The company says capex will continue to be low - Rs300m over the next two years –
which in its view will support high free cashflow generation and dividend payout
Valuations
Castrol trades at 22x CY11 (based on Bloomberg consensus) and has corrected from
peak valuations witnessed earlier this year. Castrol valuations are in-line with FMCG
companies, though significantly higher than oil companies. We believe the
comparison of Castrol with FMCG companies is not inappropriate given historically
it has achieved high capital efficiency ratios and has demonstrated pricing power
through a 15 percent hike in product prices over Dec10-Mar11.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� �
Castrol is sanguine on earnings visibility with 1) resilient demand being
driven by personal mobility and industrial segments and 2) a potential
correction in prices for key raw material - base oil
Key takeaways from the meeting
Base oil prices - a key driver: Base oil prices have had a downtick in
the last month, with decline in crude prices. While Castrol management
does not see base oil prices collapsing from current levels
(US$1,500/MT), they do believe a 13-15% fall in prices is warranted on
account of crude/base oil margins correcting on weaker global demand.
Castrol’s earnings have a 7% sensitivity to a 5% change in base oil
price, according to the company.
Volumes steady, pricing power intact. Castrol expects volumes to be
led by the personal mobility segment (cars, motorcycles) and the
industrial segment (dumpers, earthmovers). Diesel Engine Oil sales are
expected to remain flat. Castrol has taken product price hikes in Dec-10
and Mar-11, aggregating 15%, based on a prognosticated base oil range
of US$1400-1450 –further hikes may not be needed in Castrol’s view.
Castrol trades at 22x CY11P/E (based on Bloomberg consensus data), inline
with Indian FMCG companies. The company attributes this to its
strong brand/pricing power and high capital efficiency ratios.
The stock has outperformed benchmark indices over the last 12 months.
Management attributes earnings resilience to the company's ability to
pass through raw material cost pressures.
NOTE: THIS DOCUMENT IS INTENDED AS INFORMATION ONLY AND NOT AS
A RECOMMENDATION FOR ANY STOCK. IT CONTAINS FACTUAL
INFORMATION, OBTAINED BY THE ANALYST DURING MEETINGS WITH
MANAGEMENT. J.P. MORGAN DOES NOT COVER THIS COMPANY AND HAS
NO RATING ON THE STOCK.
Key takeaways from the meeting
Base oil price trends are supportive
Base oil prices have had a downtick in the last month, with decline in crude prices.
While Castrol management does not see base oil prices collapsing from current levels
(US$1,500/MT), they do believe a 13-15% fall in prices is warranted on account of
crude/base oil margins correcting on weaker global demand. Castrol’s earnings have
a 7% sensitivity to a 5% change in base oil price, according to the company.
Base oil refining margins have sustained at US$400-450/MT over the last 18 months
(v/s average US$200-250/MT earlier). Castrol sees a mismatch in the demand supply
dynamics of semi-synthetic - Group II and Group III base oils v/s the traditional
Group I base oil, while demand is shifting towards the higher grades, capacities are
yet to catch up. However, current high base oil prices have an element of supply
constraints with planned and unplanned shut-down in domestic base oil refineries
and the fire in the Formosa plant regionally disrupting supplies – easing of these
constraints will help temper base oil prices
Volumes outlook is stable; pricing power continues to be
strong
Castrol expects volumes to be led by the personal mobility segment (cars,
motorcycles) - they expect 8-9% volume growth for lubes based on a 15% growth in
vehicle sale volumes in the medium term. Industrial segment volumes (driven by
dumpers/earth moving equipment) is expected to growth at 4-5% , while Diesel
Engine Oil sales are expected to remain flat with technology changes (higher drain
intervals) offsetting vehicle parc growth.
Castrol has taken product price hikes in December-10 and March -11, aggregating
15%, based on a prognosticated base oil range of US$1400-1450. While competition
did not raise prices in 1HCY11, IOC took a big 28% hike in August; market share
impact of this is likely to be felt only in the next few quarter as Castrol management
believes there is a high level of low-price inventory in the distribution channel for
now.
Castrol continues to invest intensively in its brand and expects to maintain
advertising and sales promotion spend at 5-6% of revenues. However, there is a shift
towards more ‘below-the-line’ activities involving decision influencers (mechanics)
– to strengthen brand franchise in that segment.
The company says capex will continue to be low - Rs300m over the next two years –
which in its view will support high free cashflow generation and dividend payout
Valuations
Castrol trades at 22x CY11 (based on Bloomberg consensus) and has corrected from
peak valuations witnessed earlier this year. Castrol valuations are in-line with FMCG
companies, though significantly higher than oil companies. We believe the
comparison of Castrol with FMCG companies is not inappropriate given historically
it has achieved high capital efficiency ratios and has demonstrated pricing power
through a 15 percent hike in product prices over Dec10-Mar11.
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